Pension experts interviewed for this story, though, question the validity of the report, which compares investment firm fees with each plan’s net assets. Even with the higher fees, they say additional returns from investment managers outweigh the added cost in the long run, and tossing more money into equity index funds wouldn’t diversify portfolios.

“The suggestion that all public pensions should be shifted into index accounts is just not well informed,” said Keith Brainard, research director for the National Association of State Retirement Administrators.

Index funds -- more passive than actively-managed funds -- are structured to mirror a market index, typically making up a fourth to a third of a retirement system's total assets, Brainard estimated. These funds also come with fees, but at lower rates than actively-managed funds.

In exchange for higher fees, managers with investment firms pledge to beat the stock market. State pension systems paid fees averaging 0.409 percent of beginning-of-year assets in fiscal year 2011, according to the report.

By investing 80 to 90 percent of portfolios in index funds, the study estimates retirement systems could pocket more than $6 billion annually in payments otherwise going to investment firms.

“This would be a safer, more responsible use of system resources than paying Wall Street management firms millions of dollars each year to deliver sub-par results on public stocks and bonds and risky private alternative investments,” the report states.

But Brainard of NASRA, whose members are directors of public retirement systems, says funds can’t attain true diversification if nearly all their money is tied to market indices. Fund managers often shift money between active and passive funds depending on market conditions.

No one disputes that firms failed to meet targets in recent years. The report cites S&P Dow Jones Indices data showing 84 percent of actively-managed U.S. equity funds failed to achieve benchmarks in 2011. But in the long run, Brainard argues pension funds usually earn back fee costs. “[The report’s authors] are overlooking the potential value that is being added,” he said.

Fees paid by Missouri state, local and public school employee retirement systems, as calculated as a percentage of assets, topped all others for fiscal year 2011. Combined fees for the three retirement systems totaled $506.7 million, or 1.4 percent of beginning-of-year net assets.

Accordingly, one of these pension funds, the Missouri State Employees’ Retirement System, reported a 7.1 percent annualized return for the 10-year period up through June 2011, the highest rate of all state funds surveyed in a recent report by investment firm Cliffwater.

Of the 69 funds the firm surveyed, the following systems recorded the strongest performance over 10 years:

Rank

System

10-Year Annualized Return

1

MOSERS

7.10%

2

South Dakota Retirement System

7.00%

3

Oklahoma Teachers' Retirement System

6.90%

4

Texas CDRS

6.90%

5

Delaware PERS

6.70%

6

Louisiana State Employees' Retirement System (LASERS)

6.70%

7

Iowa Fire & Police

6.70%

8

Washington State Inv Board

6.70%

9

Massachusetts PRIM

6.50%

10

Oregon PERS

6.50%

After the Missouri systems, the Oregon Public Employees Retirement System and Maryland State Retirement and Pension System paid the next-highest fees as a percentage of beginning-of-year assets.

Much of the report focuses on Maryland’s performance, which the authors argue lagged behind others in recent years despite paying higher Wall Street fees. The Maryland Tax Education Foundation compiled data showing the system’s returns trailed six nearby state pension funds by an average of 0.9 percent over the past 10 years.

Jeffery Hooke, an investment banker who serves as chairman of the foundation, co-authored the report with Michael Tasselmyer of the Maryland Public Policy Institute, which has received funding from the conservative Cato Institute and is a member of the State Policy Network, a national group of “free-market think tanks.”

Many of these pension funds face pressure to assume lower rates of return. Shifting money to index funds would only exacerbate this, said Lisa Lindsley, director of capital strategies for the American Federation of State, County and Municipal Employees.

The amount of assets funds allocate to index funds typically relates to specific investment objectives. "I think we need to allow the governing structure of the pension funds to work," Lindsley said.

Some systems, including the California Public Employees' Retirement System, are actively negotiating with firms to push down fees.

Howard Pohl, a principal at Chicago-based investment firm Becker, Burke Associates, faulted the report for not examining how well funds achieved their individual objectives. Some funds are more aggressive than others, with performance relative to different mixes of assets.

While the funds require higher fees, Pohl said it’s more important to assess whether the actively-managed funds translate into larger returns. In general, these returns trump the cost when compared to passive index accounts over longer periods exceeding a decade, he said.

But few funds have fared well in recent years.

"We’ve been in a period of non-selectivity in the markets," Pohl said. "An index in that environment should do better."

Pohl also questioned why the report compared fees to beginning-of-year net assets rather than to totals at the end of the year.

"The implication that all these plans all over the country are being duped by these city slickers from Wall Street is extremely naïve and not supported by the facts,” he said.

Data

The Maryland Public Policy Institute compiled net assets and investment fees from major state retirement systems' comprehensive annual financial reports. Some figures were summed from multiple systems; specific CAFR reports used are listed on pages 4 and 5 of the report.

Figures listed are in million dollars.

State

Fiscal Year

Year-Starting Assets

Year-Ending Assets

Management Fees

Fee % of Beginning-of-Year Assets

Alabama

2011

25,435.65

25,092.79

14.234

0.056

Alaska

2011

13,807.67

16,489.64

90.162

0.653

Arizona

2011

27,978.79

33,531.45

150.121

0.537

Arkansas

2010

13,152.80

14,612.07

51.912

0.395

California

2011

334,495.65

401,194.34

858.942

0.257

Colorado

2010

35,036.94

41,135.79

153.924

0.439

Connecticut

2011

21,869.59

25,183.67

89.625

0.410

Delaware

2011

6,372.54

7,648.78

22.302

0.350

Florida

2011

107,179.99

126,579.72

354.999

0.331

Georgia

2011

59,604.13

69,563.89

35.08

0.059

Hawaii

2009

10,846.79

8,815.29

80.504

0.742

Idaho

2011

10,410.58

12,377.60

41.851

0.402

Illinois

2011

50,085.91

59,452.46

297.667

0.594

Indiana

2011

22,182.16

25,755.67

137.421

0.620

Iowa

2011

19,878.08

23,082.13

41.933

0.211

Kansas

2011

11,369.74

13,468.85

47.586

0.419

Kentucky

2011

25,753.16

30,292.27

92.432

0.359

Louisiana

2011

20,076.11

24,280.71

132.86

0.662

Maine

2011

9,225.96

11,051.69

19.705

0.214

Maryland

2011

31,923.70

37,592.80

221.243

0.693

Massachusetts

2011

41,284.31

50,245.77

69.218

0.168

Michigan

2011

47,132.26

46,106.07

186.661

0.396

Minnesota

2011

44852.43

53,075.45

66.928

0.149

Mississippi

2011

18,274.11

22,133.85

42.765

0.234

Missouri

2011

36,661.68

43,421.12

507.662

1.385

Montana

2011

6,994.38

8,305.94

42.819

0.612

Nebraska

2011

8,200

9,600

(omitted)

(omitted)

Nevada

2010

18,770.14

20,906.28

23.899

0.127

New Hampshire

2011

4,898.34

5,891.18

18.446

0.377

New Jersey

2011

74,648.17

81,067.61

13.417

0.018

New Mexico

2011

18,712.60

22,131.22

52.487

0.280

New York

2011

272,878.87

315,448.87

821.513

0.301

North Carolina

2011

65,300

74,900

295.1

0.452

North Dakota

2011

3,127.74

3,743.38

20.759

0.664

Ohio

2010

140,766.21

153,981.87

296.142

0.210

Oklahoma

2011

14,341.30

17,220.81

43.4

0.303

Oregon

2011

51,739.65

61,189.78

364.687

0.705

Pennsylvania

2010

67,868.99

71,723.63

758.141

1.117

Rhode Island

2010

6,069.03

6,577.14

13.052

0.215

South Carolina

2011

22,691.66

25,891.85

71.05

0.313

South Dakota

2011

6,496.63

7,936.27

37.852

0.583

Tennessee

2011

28,574.20

33,663.31

32.213

0.113

Texas

2011

116,983.29

130,518.44

246.957

0.211

Utah

2011

23,012.75

23,218.74

50.105

0.218

Vermont

2011

2,956.97

3,470.32

13.993

0.473

Virginia

2011

47,651.23

54,562.26

320.03

0.672

Washington

2011

57,630.14

68,311.83

227.902

0.395

West Virginia

2011

8,946

10,750.84

28.167

0.315

Wisconsin

2010

69,996.30

75,872.07

245.806

0.351

Wyoming

2010

6,006.53

6,665.57

17.28

0.288

Information compiled by the Maryland Public Policy Institute. Please refer to the group's report with links on pages 4 and 5 to view the source for state figures.